New tax rules for life insurance policies will become effective
on January 1, 2017. In most cases, the tax benefits under the new
rules will be reduced compared to policies issued pre-2017. If you
are considering the purchase of life insurance as part of your
estate plan that means you should act soon to avoid falling under
the new regime.
The changes are intended to modernize the tax rules for life
insurance, which were last revised in 1982. Since then, people are
living longer, interest and inflation rate conditions have changed
and a vast array of new insurance products have
The most significant revisions involve modifications to the
regulations used to determine the maximum amount that can be
invested to satisfy the exempt test2
In general, policies issued before January 1, 2017 will be
"grandfathered" and will continue to follow the current
exempt test and policyholder taxation rules. However, there are
certain triggers that could remove the grandfathering status of an
in-force policy. For example, if life insurance coverage is added
to the policy, with medical underwriting that occurs after 2016,
the policy will no longer qualify for grandfathering. Also, if term
insurance is converted into permanent insurance after 2016, the
grandfathering will cease.
What are the key changes to the rules?
Corporate-owned life insurance
One significant change relates to corporate-owned life insurance
and the amount that will get added to the capital dividend account
(CDA) on the death of the shareholder. This is important since the
amount in a CDA can be distributed tax-free to shareholders.
For policies issued after 2016, an insurance policy's annual
net cost of pure insurance will generally be lower. This change
will ultimately alter the adjusted cost base (ACB) of the insurance
policy and will result in lower additions to the CDA.
If you are considering a corporate-owned life insurance policy,
perhaps to assist with the buy-out of shares under a
shareholders' agreement, consider acquiring the policy before
the end of 2016.
Using life insurance policies as collateral for loans
Life insurance policies with a cash surrender value (such as
universal and permanent life policies) are often used as collateral
to provide funding for business or investment purposes. This is
often referred to as "leveraging" the life insurance
policy. One advantage is that, where the policy is assigned to the
financial institution as a condition of the loan, a portion of the
insurance premiums may be deductible. The amount deductible is
based on the lower of the premium paid in the year and the net cost
of pure insurance in respect of the year.3
Under the new rules, where life insurance policies are used as
collateral for a loan, a reduced percentage of premiums paid will
generally qualify for a tax deduction.
Insured annuities can be a suitable investment strategy for
older investors who have a significant amount of non-registered
funds which they don't want to put at risk. They are looking
for a steady income stream, but they want to leave an estate for
their children or grandchildren, and current GIC rates are too
The insured annuity involves the purchase of a life annuity to
generate a guaranteed income for life. A permanent life insurance
policy is then acquired with a death benefit equal to the amount
invested in the life annuity. The annual net after-tax yield from
the annuity is higher than could be earned in a GIC and is
guaranteed for life. On death, the annuity income ceases and the
original capital is returned to the estate as a life insurance
The new rules will result in an increase in the taxable portion
of annuity income payments, which will reduce their tax
effectiveness. As such, if you are interested in an insured
annuity, you should consider a pre-2017 acquisition to take
advantage of their current tax-efficiency.
If you or your business require life insurance products as part
of your overall investment portfolio, or if you need to put life
insurance in place to meet other requirements, we would be pleased
to work with you and your insurance advisor before the changes take
place to help you maximize your tax benefits and meet your business
1 e.g., universal life insurance
2 A policy is exempt where the internal growth of the
cash value (i.e., investment income attributed to the policy) is
not subject to annual accrual taxation. Virtually every policy
issued in Canada is structured so that the policy growth falls
within the parameters required to be an exempt
3 Paragraph 20(1)(e.2) of the Income Tax
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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